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14 February, 2017
Vietnam has worked on attracting FDI with a reduced Corporate Income Tax for prioritized sectors, with a lowered standard rate – from 25 to 10-20 percent – and by waiving the land rental fees for Foreign Invested Enterprises (FIEs). If the FDI are promoted, it is mainly due to the technological transfer they include. Despite the increasing number of foreign invested enterprises in Vietnam, the spillover effects are still expected because of the lack of three conditions: dense backward linkages, geographical proximity and FDI absorptive capacity.
Our first concern tackles the lack of backward linkages created by Vietnamese firms. More than half of the FIEs import inputs from home or from a third country, depending on several factors: the suppliers form, the sector and the country of origin.
FIEs are mainly served by private and import suppliers, even though the percentage of FIEs by suppliers’ type varies within each sector. Finance and services are the two sectors with the most backward linkages since they rely on human capital. In manufacturing and mining sectors, the FIEs import more than half of the inputs from another country.
Besides, the FIEs are diversifying their sources, showing a change of sourcing strategy regardless of the investment incentives they receive. The suppliers’ types are more diverse than it used to be: in 2-year time, 45 to 68% of the FIEs served by domestic private suppliers, 10 to 20% served by household suppliers… the in-house sourcing is the only supplier form which has decreased.
The many incentives are meant to promote FDI in high-tech sector, underprivileged regions and other priority sectors, but we can question the reality of the technological transfer. Indeed the incentives target regions and sectors that are not ready to receive such advanced technologies and therefore FIEs in more developed regions do not rely on incentives.
Across provinces, the main sectors determine the source of FIEs suppliers considering the complexity of the technology needed for the activity. Vietnamese suppliers are more able to form linkages with FIEs in lower-tech sectors, where the technological gap is not prohibitively large. Thus, more linkages are established with Taiwanese companies which concentrate on textiles, light manufacturing and light electronics, than with Japanese or Korean companies specialized in complex electronics. FIEs are under no obligation to transfer their technology which prevents Vietnamese firms to join the high-tech supply chain and to establish forward linkages.
The geographical proximity between the FIEs centers and the domestic private firms must be greatly considered as the transfer of technology mostly occurs in face-to-face technical consultations. Yet, it is difficult to draw a distinction between the proximity impact and the domestic firm’s strategy.
In either case, the proximity has an influence over the choice of strategy and a close proximity ensures a better technological spillover. The establishment of a private domestic firm in an industrial zone increases the efficiency of exporting but diminished the chance of technological transfer by isolating the FIE from a larger economic pole.
Finally, the FDI absorptive capacity facilitates even more technological transfer. Indeed, if the gap between the domestic enterprise and the FIE in matter of new technology and of work force training is too large, the potential for transfer is reduced.
In matter of labor quality, State-Owned Enterprises have a higher percentage of high-quality labor when domestic firms have less educated labor force. The quality of the work force is crucial to adopt FIE’s technologies and management techniques. Thus, domestic suppliers of FIEs are less likely to assimilate from their foreign clients due to a more limited absorptive capacity. Improving labor quality is the key missing in promoting FIEs technological transfer. The linkages and the proximity only allow people to get in touch and enhance a better spillover.
Guidance on the EVFTA
It is a golden time to invest in Vietnam due to the FTA, Vietnam being the only ASEAN country to sign this agreement with the EU (Singapore has signed the FTA in 2014 but this does not affect Vietnam’s competitiveness as Singapore mainly exports machines, chemical products and transport equipment).
Under the provisions of the agreement, over 99% of the tariff lines will be eliminated within 7 years from the effective date of the FTA. Vietnam’s duties on EU exports will disappear in a ten-year period, EU’s duties in a seven-year period for some products (motorcycles, car parts, half of EU pharmaceutical).
The opening of the market will emphasize commercial relations between EU and Vietnam and benefit to both of them. Vietnam’s commitments to World Trade Organization (WTO) and to additional (sub)sectors such as Interdisciplinary R&D services, nursing services, packaging services etc. offer the EU partners best possible access to Vietnam’s market.
For the distribution sector, an Economic Needs Test is required, as for the WTO, but with exemptions and time delay of five years after the date of entry into force of the Agreement. Thus after 5 years, the requirement of the ENT will be abolished.
Vietnam is the most investment worthy place in ASEAN and will ensure this position partially thanks to EU-VN FTA. Its stable development of the economy and controlled inflation, its adapted legislation foster an environment proper to investment.
Most important issues
Consider what suppliers’ form is the most suitable to be served by, regarding the technicity of the activity.
Choose the relevant strategy to adopt between perceiving incentives but letting go of linkages, and establishing backward linkages with the domestic firms’ even if it means waiving incentives.
Decide the timing to invest: Vietnam is the new land of investment this is why investors should position themselves as early as possible to timely grab the opportunities that FTAs create when they come into effect.
Pay attention to the newly adopted legislation: the Government tends to improve the business climate by reforming the legislation, especially when new trade pacts are coming into effect (e.g. Investment Law, Enterprise Law, decree on Public-Private Partnership).
For further information, please contact:
Oliver Massmann, Partner, Duane Morris
omassmann@duanemorris.com
